Global Rates: ECB, cross-market views and UK politics update

Hi, and welcome to At Any Rate, J.P. Morgan's global research podcast series, where we take a look at some of the drivers behind the biggest trends and themes across fixed income, currencies and commodity markets. I'm Francis Diamond, head of European rate strategy at J.P.

Morgan. And today I'm joined by my colleagues, Kigendre Gupta and Aditya Chaudhary to discuss Euro area rate markets ahead of next week's ECB meeting, with a focus on cross market themes, as well as provide an update on UK politics and any spillovers into the UK gil market. So ECB commentary over the past couple of weeks has pretty clearly signaled a rate hike at the upcoming June meeting.

And the latest flash inflation print showed a significant increase in services inflation in May to three and a half percent, with overall call inflation running at 2.5 percent. Front end European rates are almost fully pricing a 25 base point hike from ECB at the June meeting, with more than 50 base points of hikes priced by year end and cumulative 70 base points of hikes by the first quarter of 2027. So let's start with ECB next week.

Kigendre, given this pricing, what do you expect the message to be? And do you think they can surprise at all versus market expectations? Thanks, Francis.

You know, the June hike itself looks like a done deal. And as you mentioned, this is fully priced and is in line with our own baseline. The key question, as you put it in your question, is the message beyond June.

I expect President Lagarde to reiterate ECB's data dependent and meeting by meeting approach. I think that the ECB cannot sound relaxed. You know, energy prices remain elevated.

Headline inflation has moved higher, as you just pointed out. And they will want to guard against second round effects. But growth is also weakened.

So I do not think they will be committed to a full hiking cycle here. As usual, President Lagarde will highlight both sided risks to inflation and growth and likely keep the directional bias of higher rates. On market pricing, I think, you know, the 50 basis point by year end is reasonable, but around 70, 75 by first quarter's 27 is close to the upper end of what should be sustainably priced.

Our baseline is for two hikes. That is in June and September. But risks are skewed towards fewer in my mind, rather than more.

To justify three hikes, you need persistent energy pressure, evidence of second round effects and growth holding up. I think that the key difference between now and 2022 long hiking cycle is that the ECB is not starting from deeply negative rates or clearly behind the curve. Policies are already closer to neutral.

So the need for a catch up cycle is lower. So with that, I think the likely message for next week should be hike in June, keep the door open, but avoid validating the full 70, 75 basis point path. If Lagarde sounds hawkish on inflation, but cautious on the path, that could be slightly divergent in my mind versus current market pricing.

Okay, so if we think further out the curve of DTR, we look at bunds, you've been highlighting a range trading environment, the 10 year par curve under our Middle East conflict scenarios. Yields are kind of grinding up towards the higher end of that range. But do you see any opportunities outright or cross market here?

Yeah, thanks, Francis. So yeah, what we've been saying is like the 10 year bond yields have been trading in this 285, let's say 310, 315. So there's 20 basis point or so range.

And that's the range we expect across the range of Middle East scenarios we have with a higher conviction, which is somewhere between 90 to 310. And after this week sell off, we are getting in the upper half of the range, but not still a bit away from the upper end of the range. What we prefer is tactically we have a bias to overweight German duration, when yields get closer to the upper end of recent ranges.

So that's how we are thinking about playing those ranges. And also on a cross market basis, we also have a bias for overweighting Germany versus US rates given attractive valuations. Like even after the large post payroll US and the performance we have seen today, we find that 10 year US Germany spread is still trading around seven basis point to time, that US yields are around seven basis point expensive versus Euro yields in the intermediate sector.

And that's after adjusting for relative front end expectations and relative changes in forecast revision indices. So overall, the valuations are quite attractive for those type of overweight Germany versus US biases. Okay, makes sense.

So maybe again, if we just talk a little bit about a different part of the market and swap spreads and seasonal dynamics around May and June, which sometimes come into focus for market participants. So maybe if you can explain firstly, what the dynamics are, and then secondly, what you expect going forward. Yeah, so just to recap on spreads, you know, I think the main point is that German sub spreads have moved back into a much more range bound flow driven regime.

Earlier in the US Iran shock spreads were more correlated with yield curves and volatility because the market was translating energy headlines into ECB pricing. That relationship has now faded quite a lot. Yields have settled into a range of funding markets look stable and spreads are no longer traded like a clean macro or risk of proxy.

So it boils down to what seasonality is doing as a near term driver on spreads. Now, on seasonality, as we've discussed in the past, you know, this matters most in the intermediate sector, particularly say bubble and wind spreads. Sub issuance has been elevated this year, compared to historical averages, and that would usually create narrowing pressure and wind spreads.

That has been part of the reason investors like bond narrows earlier. But as we move to the June issuance starts to decline, going into the summer weeks before picking up back in September. And it's the seasonality we expect to hold this year as well as is the case every other year.

When spreads also tend to react commensurately, that is widening over the June, July period and then narrowing modestly in late August, September. And that said, the markets knows the seasonal pattern very well. We have already seen some profit taking in bond narrows and bond spreads have not narrowed as much as one might have expected, given how strong swap issuance has been.

So I would not rush into say bond wideners immediately. Our view is that more being more patient, stay neutral for now. And if bond spreads tighten another couple of basis points, then in my view, tactical wideners become more interesting.

Francis, let's switch to the UK now, you know, the maker field by election is now less than two weeks away. And the latest polls show a 10% lead for labor and Andy Burnham over reform. Has this impacted gilt markets and do you see potential for any political risk premium in gilts?

So as you say, yes, the second opinion poll we've had from Survation now puts labor, which is Andy Burnham, as you say, 10% ahead of reform, which is compared to about a 3% lead seen in the first opinion poll that was conducted towards the end of May. But to be honest, there's been very little impact from either of these polls on guilt yields. And this week, UK yields have been broadly rising across the curve, reflecting mostly high energy prices and the sell off we've seen in bonds and to some degree, treasury.

So really, global factors at play rather than anything UK particular at this point in time. And if we look at the 10 year part of the curve, 10 year gilts round about 4.9% are still 30 basis points below our sort of energy shock scenario for the Middle East conflict. I mean, as we've been highlighting in our publications, a Burnham victory in the by-election still seems fairly likely.

It's not assured. And we are seeing continued media focus on potential leadership challenge from Burnham in the coming weeks once he becomes an MP. And actually, from a market perspective, comments from Burnham this week have continued to give little away about any potential policy changes if he were to become PM.

But Andy Burnham has pretty much stated he would stick to the labor manifesto pledges from the last general election, which comes on top of comments he's made previously about maintaining fiscal rules. So I think the sense here is markets are probably not really becoming too concerned around what a Burnham victory in the leadership election might mean. But I guess we also have a possibility that if PM Starmer continues to state he would not step down and a leadership challenge were to emerge, possibly if there is no other labor MP also launching their own leadership challenge alongside Burnham, then it is possible Starmer might decide to step down without any formal contest.

But at this stage, I think it's quite unclear exactly timing or it's quite unclear exactly what sort of form a labor leadership contest would take. So possibly we could be talking about a Burnham in these sort of scenarios. It could be prime minister by mid-July at the earliest, but potentially that could still be a few months away if a leadership contest drags out.

But from a market perspective, we think there's just limited visibility on what any potential fiscal policy changes could look like until we get much closer to an autumn budget later this year. So thanks Kigendre, thank you Aditya, and that's all from us. Thank you for listening and stay tuned for more updates on fixed income here on At Any Rates, JPMorgan's global research podcast series.

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All Rights Reserved. This episode was recorded on the 5th of June, 2026.